CWS Market Review – April 5, 2022

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Elon Musk Buys a Big Stake in Twitter

Earlier this week, Elon Musk announced that he had taken a 9.2% stake in Twitter (TWTR). According to SEC rules, you have to make your positions public if you buy more than 5% of a publicly-traded company. The market was euphoric. On Monday, shares of Twitter rallied nearly 30%.

Thanks to his big buy, Musk was given a seat on Twitter’s board of directors. That triggers another SEC rule. Musk can’t be the owner of more than 14.9% of Twitter’s stock until after his term on the board ends which is in 2024. Basically, that means that we shouldn’t expect Musk to bite off many more large pieces of Twitter.

Musk’s stake in Twitter may sound like a lot, but it’s “only” $3 billion. That’s pocket change for Musk. With a fortune of $267 billion, Musk is the wealthiest man in the world.

With Monday’s big rally, Musk is already sitting on a nice profit. In this case, the market’s reaction may be more than idle speculation. Don’t expect Musk to be a silent investor. Musk has talked about making changes to the social media site. He has criticized its willingness to ban some well-known individuals while going light on others. Musk even polled his followers to ascertain the popularity of an edit function. (Yep, it’s very popular.)

With this investment, there’s an odd dynamic at work. A mega-billionaire can quietly buy a stock and then make the news public and watch the market send the investment much higher. Of course, there aren’t many people who can move the market like that. Maybe Warren Buffett is the only other.

In the past, Musk has hinted that he may want to start a rival to Twitter. I suppose he thought buying the thing was the easiest path. Having a quarter of a trillion dollars opens some options.

I should say that in a strict numbers sense, Twitter is not a very profitable company. Last year, the company made a profit of 20 cents per share. The shares are currently around $51, which gives the stock a P/E ratio of roughly 250. That’s about 15 times what a normal company would go for.

Of course, Twitter is not a normal company. This gets to the heart of a matter that’s very difficult for securities analysis: how do you value a relatively new company that’s growing quickly but is not very profitable? Nonconventional businesses should be looked at in nonconventional ways. Personally, I avoid such stocks. It’s not that I’m not a fan of the companies, but I simply can’t see which stock will emerge as the winner.

If you had gone into a brokerage firm 40 years ago and boldly announced, “Computers are the future! That’s where I want to invest!,” the firm most likely would have recommended stocks like Wang and DEC. Probably IBM. Maybe Apple, but that would have been the oddball choice.

My point is that even if your thesis was correct and computers had indeed been the future, finding the winners would have been very difficult. There used to be 400 domestic automakers in the U.S., but it wasn’t long before the industry became known as the Big Three.

I think there’s great potential for Twitter, but the current model isn’t working. If there’s anyone who has the pull to make a big winner out of Twitter, it’s Musk. I wish him well.

Get Ready for Three Straight 0.5% Hikes

Tomorrow, the Federal Reserve will release the minutes from their last meeting. Of course, this was the meeting in which the Fed decided to raise interest rates for the first time since 2019.

My view is that the Fed is way behind the curve and it needs to be far more aggressive in fighting inflation. I’m not alone. James Bullard, the top guy at the St. Louis Fed, agrees. He cast the lone dissenting vote at the last meeting.

I have to explain something about the Fed’s minutes. They never use specific names. Instead, it’s an amazing study in the use of indefinite pronouns. “Some” said this. “Several” agreed that. “Few” countered with this.

The minutes can be difficult to decipher, but I want to see how worried the members are about inflation. The minutes are usually released three weeks after the Fed meeting. The next meeting will be in in four weeks.

For now, the futures market expects to see a 0.5% increase in May, another 0.5% increase in June and another 0.5% increase in July. That’s more aggressive than the Fed has been signaling.

On Friday, the government released the March jobs report. During the month, the U.S. economy created 431,000 net new jobs. That’s another good report. Wall Street had been expecting 490,000. The numbers for January and February were revised higher as well.

The unemployment rate fell to 3.6%. That’s another post-Covid low. It’s also lower than every single month from January 1970 through August 2019 (see chart above).

The broader U-6 rate fell to 6.9%. That’s just 0.1% above the all-time low from 2019, although that series only goes back to 1994.

One weak spot is that average hourly earnings grew by just 0.4%. In the last year, average hourly earnings are up 5.6% which is less than inflation. The next inflation report will be out next week. This report will also be the first one to feel the effects of the war in Ukraine.

Lael Brainard, who is President Biden’s pick to be the next vice-chair of the Fed, spoke today about the impact of inflation. She underscored an important point that inflation weighs heavily on lower-income consumers. She gave the example of a family that regularly buys a brand-name cereal. When inflation hits, they can easily go to store-brand cereal. But a low-income family that already buys the store-brand can’t make that switch. When inflation is running at 8%, it’s not 8% for everyone.

Speaking of finding a good bargain, let’s look at a retailer that’s thriving in the Age of Amazon.

Stock Focus: Five Below

In recent years we’ve heard a lot about the great “Retail Apocalypse,” and it’s true that Amazon has changed the game permanently for a lot of retailers. We’ve also seen the death spirals of once-mighty retailers like JC Penney and Sears and many others.

But not everyone is being done in by Bezos and his ubiquitous retail machine. One standout is the quirky Five Below (FIVE).

There’s something so elementary about Five Below that makes it brilliant. The concept is simple: They don’t sell anything for more than $5.

The store is specifically geared toward teens and pre-teens. Their tagline says it all: “hot stuff, cool prices.” Five Belows are also purposely located in strip malls. That helps keep the rent down.

They’ve hit onto something big. The company was founded in 2002 by David Schlessinger and Tom Vellios. These were the guys behind Zany Brainy.

The stock IPO’d ten years ago. Today, there are over 1,200 stores across 40 states. The company has very ambitious plans for growth. Five Below aims to triple its number of stores by end of fiscal 2030.

So what is it, exactly, that they sell? You name it. As long as it’s less than $5. They sell things like toys and games, or cheap accessories. A lot of it is tacky. A lot of it is silly. But it’s all well-planned.

Are you in the market for an inflatable furry ottoman? Well, Five Below has got you covered. A pink duffel bag? Yep, they’ve got that too.

The items aren’t supposed to be important. Instead, they’re supposed to fun impulse buys, but that’s the secret that sets them apart from Amazon. What Five Below shoppers like is the “treasure hunt” experience. A group of friends will spend time digging through their shelves. This is something Amazon can’t recreate online. By the way, the stores do have sections for $10 items.

Five Below knows their customers. They don’t come in looking for the item they’ll eventually buy. They want to spend time combing through dozens of items before selecting a final few. As odd as it may sound, they come for the Five Below experience.

Apparently, there’s a lot of business in $5 items. For the fiscal year ended in February, Five Below had sales of $2.85 billion. (That’s a lot of stuffed neon green hippos.) That’s also a 45% increase over the year before.

Silly stuff is serious business. Gross margins currently run around 36% which is quite good for a low-cost retailer. Operating margins are 12% and net margin comes in at just under 10%. That’s an efficient shop.

This is no small business either. Five Below currently has a market value of more than $9 billion and it’s a member of the S&P 400 Mid-Cap Index. The CEO summed it up perfectly: “We’re the T.J. Maxx for kids.”

Here’s what else I like. Five Below has a solid balance sheet. The firm doesn’t owe a dime in long-term debt. Make no mistake, the company got hit hard by the coronavirus lockdown. In June 2021, Five Below reported a fiscal Q1 loss of 91 cents per share.

That hurt but things are looking much better now. The gradual passing of Covid is also very good news for Five Below. Last week, Five Below reported fiscal Q4 earnings of $2.49 per share. That beat the Street by one penny per share. That was the seventh quarter in a row that Five Below beat the Street. For Q4, earnings grew by 13.2%. In times of inflation, consumers become more price sensitive which is good for Five Below.

Joel Anderson, President and CEO of Five Below, stated, “We were very pleased with our fourth quarter results that capped off a record year. We delivered sales growth in line with our expectations against the difficult comparison to last year’s stimulus-fueled comparable sales increase of 13.8%, and despite the impact of weather in January. The strength was broad-based, with Sports, Candy, Seasonal and Style worlds outperforming.”

Let’s look at guidance. For fiscal Q1, Five Below expects sales between $644 million and $658 million, and earnings between 54 and 62 cents per share. For the whole year, Five Below sees sales ranging between $3.16 billion and $3.26 billion, and earnings between $5.19 and $5.70 per share. That’s up from $4.95 per share last year. Frankly, the guidance is a bit lower than I expected.

Last summer, share of Five Below got $237. The stock has drifted lower since then. On Tuesday, it closed at $165.74 per share. That’s still a little high for me, but I’d be interested if Five Below goes below $140 per share. This off-beat retailer is one to watch.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on April 5th, 2022 at 9:09 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.